From SCDigest's On-Target e-Magazine

More Talk than Action, by some Accounts, as Most Risk Reduction Strategies Add Cost; Pushing on Suppliers to Take Action - that's a Different Story

SCDigest Editorial Staff

2011 was an important year in the science of supply chain risk management, due to a couple of major natural disasters that had a significant impact on supply chain performance.

First was the earthquake and resulting tsunami in Japan in March of last year, which apart from the human suffering caused major supply chain disruptions across many sectors - with many companies caught by surprise.

SCDigest Says:

While political risk has always been around, it has been brought into greater relief in recent years, with the turmoil in the Middle East overall and the toppling of governments, such as in Egypt.

What Do You Say?

The automotive supply chain, especially for Japanese OEMs Toyota and Honda,took the biggest wallop, with parts supplies extremely constrained for months, and production and sales levels way down as a result. In fact, Toyota lost its position as top global car producer in 2011, handing the title back to GM after several years on top (some say the winner should actually be Volkswagen, depending on how the numbers are counted).

But the bigger surprise was the number of companies that took supply chain hits from supply disruptions relative to sources that had not been high on their radar lists. For example, a number of industries were constrained by shortages of obscure chemicals that represented just a small but vital component of their manufacturing processes, and which turned out to be either only or largely sourced from Japan. As those suppliers lost production capabilities, in some cases for months, manufacturers across the globe were sent scurrying for other sources or to find alternative materials.

In the second half of the year, months-long flooding in Thailand also hurt global supply capabilities in a number of high tech sectors, especially the disk drive industry, which is hugely concentrated in the country and which came to a near total halt for many weeks. Intel, for example, said it lost about $1 billion in Q4 sales because computer OEMs were not buying its chips because they were unable to source the hard drives needed to make new machines.

Other areas, such as aircraft tires, have also been affected by the Thai flooding.

As a result, many pundits said it was time for companies to once again think more comprehensively about supply chain risk, and be more concerned with looking beyond first tier suppliers to their suppliers' suppliers, among other improvements.

But now almost a year past the Japanese earthquake, has much really changed in how companies manage supply chain risk?

Yes and no - depending on who you ask.

A recent Wall Street Journal article says the events did cause many companies, even those not affected by disruptions from Japan or Thailand, to relook at their potential supply chain risks from new angles, to see if they too might have hidden risks they weren't well aware of previously.

But in terms of actual supply chain practice, it turns out making changes that cost money today for the sake of mitigating risks that may or may not ever emerge is not highly popular in the executive office.

The awareness of new supply chain risks "hasn't necessarily led to action," the WSJ piece says. "That's partly because boosting inventory even slightly to provide a cushion against supply disruptions can cost big companies millions of dollars, taking a noticeable bite out of the bottom line."

One problem is that it is extremely hard if not impossible to cost justify adding certain supply chain redundancies absent an actual major disruption that can demonstrated what the impact would have been if the steps had not been taken. That makes it hard to get much executive enthusiasm behind such mitigation moves unless the pain of a recent disruption is still fresh in mind.

The WSJ article quotes Sean Cumbie, vice president of global supply chain at German genetics-testing company Qiagen, as saying "If we're lucky, [we get] absolutely zero return" from such risk mitigation moves. The implication: often the moves cost money in the short term, and even the long term if certain feared risks never materialize.

The article notes that while large companies themselves may therefore be reluctant to take certain risk mitigation steps, they are happy to give advice to key suppliers about moves they should be making.

For example, after the Japan earthquake, contract manufacturer Jabil Circuit met with most of its major Japanese suppliers to encourage them to develop more than a single source for parts and raw materials. and also urged them to stop clustering their factories around their headquarters. Jabil also says it too is moving towards use of more dual sourcing for many components.

Even beyond the potential cost impact of reducing supply chain risk, another barrier is simply the time it takes to do the analysis and develop alternative or contingency plans - time that is in short supply for most supply chain executives today. Paul Tronsor, managing director of global operations control, noted the amount of time it took his company to understand the lessons from the 2010 Icelandic volcano eruptions that disrupted flight schedules for weeks, and then days spent visiting different areas of the company to explain how such disruptions might be better handled in the future.

Gene Tyndall, an executive vice president at consulting firm Tompkins Associates, agrees that companies have perhaps talked more about taking additional steps to reduce supply chain risk coming out of the disasters than have taken real action.

"Despite lots of talk about risk management, its actual applications in supply chains are fewer than expected," he told SCDigest. "Our benchmarking and corporate experiences indicate that while many companies do have contingency plans, especially for weather and labor disruptions, most do not actively change suppliers and/or sourcing locations.

He added that "international sourcing and routings are complicated, and changes are not easily done with efficiency. A best practice is to work more closely with logistics service providers so that flow impacts from supply chain disruptions are better managed."

Dr. David Simchi-Levi, a professor at of MIT and author of the recent book Operations Rules, sees a similar lack of real action - though notes there are exceptions.

"I agree, most companies talk about risk but do very little to change their approach," Simchi-Levi told us. "Many exceptions exist however, including giants like Toyota and others who are investing significantly in their supply chain to increase their resiliency and responsiveness."

He says a prime reason most companies do very little in response to the major disruptions over the last few years is because they are not sure what to do.

"Typically, the argument that you hear from senior executives is that "a volcano eruption like the one in Iceland in 2010 or a tsunami like the one in Japan last year occur once every two hundred years, so there is very little that you can do to prepare for it." In my opinion, this is the wrong view," Simchi-Levi adds.

He says that there are so many potential disruptions, or what he calls the "Unknown Unknowns," that even if each occurs very infrequently, because there are so many of them, something will go wrong in the next twelve months - and that surprisingly there is a lot that a company can do to plan its supply chain so that it can mitigate these types of risks.

Add Political Risk to the Mix

While political risk has always been around, it has been brought into greater relief in recent years, with the turmoil in the Middle East overall and the toppling of governments, such as in Egypt, that no one would have expected just a couple of years ago.

Political events, especially the fall of a government, can be just as disruptive as a major natural disaster, and just as hard to predict. Procter & Gamble was forced to close a couple of factories in had in Egypt for weeks at the height of the protests, and spice maker McCormick told the Wall Street Journal that the events in Egypt led the company to stockpile the various herbs it bought there and secure alternative sources in more stable parts in the Mediterranean.

Political risk, especially in Europe as various austerity measures take hold as a result of the debt crisis there, appears likely to get worse before it gets better across the globe..

One thing everyone can agree on - globalization and Lean supply chain practices have made today's supply chains a lot more risky than ever before.

Do you think most companies have made real changes to their practices to reduce risk as a result of recent major disruptions? Should they? How can you really quantify risk? Let us know your thoughts at the Feedback section below.

Recent Feedback

There has been a lot of research on the effect of devastating effects (D.E's) on supply chain and inventory management. One issue with risk analysis of D.E.'s is generating the model to account for its effects and mitigation. There is an increasing use of lean, single sourcing etc. At the most basic level it would be simply the cost to the business of a D.E. The frequency of occurrence and impact of the D.E. is the tricky part. People have done research modelling, implementation of such research would be interesting. It would be interesting to know more what Toyota has done to reduce the risk to their supply chains. I do not know if it is relevant but Toyota's use of red stream/green stream production might have something to do with it.

Vipul Saxena
Analyst
Gonzaga
Jan, 19 2012

Risk profiling considered lean term adequacy. Strategies are necessarily long term. If not the carbon footprint, rising transportation and wage hikes inevitability offshore should have taken into account for at least a couple of decades. Flow of capital is flow of industry and enterprise and its painstaking return if any shall be with different owners, eroded values and adulterated worth to the citizens or the exchequer. Risk Management is necessarily very restrained approaching Wall Street.